As a CEO, you have a lot on your plate. So, out of all the potential development projects in your company, why should you focus on pricing? Quite simply, it gives you the most bang for the buck.
To illustrate my point, I’ll invite you to join the (fictional) life of Tom, the CEO for Steel Components Ltd.
Tuesday morning 9.00
You’re attending the quarterly review meeting with your management team and the controller, Lukas, projects the latest sales and profitability figures for Q4. “Revenue has plateaued when comparing to the previous two quarters as well as year-to-year development.” No surprises there. The sales director, Martin, has reported about the difficulties in bringing in new clients. On the up-side, he has been satisfied with the fact that customer churn has been at an all-time low.
Lukas continues by displaying the development of profitability. The nerves kick in. Just last week, the issues of rising costs with 2 major suppliers was brought to your attention by the sourcing team and you know it’s going to hit hard on profitability. But, by how much?
Lukas carries on, and projects the hard numbers. EBIT is down by 30% from last quarter and almost halved from a year-to-year comparison. You sink in your chair. You knew it was going to be bad. But THAT bad? With the rises in global aluminium prices, it hasn’t been an easy year for the industry in general. However, at the same time your most fierce rival, ALU Ltd, has grown its market share and announced it's opening a new production facility close to your headquarters. The board is not going to have it.
Your CFO, Kim, starts raging how this could have been prevented by switching to cheaper foreign suppliers a long time ago. As the blue fluorescent light from the projector hits you at an angle you daze off into your thoughts.
We have a serious profitability problem.
After wallowing in self-pity for a while and trying to console yourself that maybe unemployment isn’t that bad once you’ve crashed and burned your career, you recall the inspiring business conference you attended last month. “To solve any problem, you must start by dissecting it into smaller parts”. That’s right! Issue trees you practiced with your college roommate years ago flash before your eyes, and it hits you. Okay, so we have a profitability problem. What does profitability actually consist of?
Simply put, profitability is sales minus costs. Sales composes of the volume of units times revenue per unit, in other words price. Costs then again can be divided into fixed and variable costs.
Well, as your CFO just stormed, you should change suppliers to get variable costs into control. However, you’re not entirely convinced about this strategy, as the last company you worked for tried switching long-time suppliers in chase of a few percentage savings in raw materials only to find out that the quality was nowhere near your domestic provider and it resulted in a lawsuit with one of your key accounts. No-go for that.
Fixed costs can’t really be touched, since people are overemployed as they are and you just switched to a new, modern, energy-efficient production facility last summer. Sales has been working hard to close new clients and you know their luck will turn any time soon. However, the market is small and competitive to begin with, so the potential for a significant boost in sales volume through client acquisition is minor.
Then you think about revenue per unit – pricing. When is the last time you had an increase in prices based on risen costs? When is the last time you raised prices in general? Has it been systematic in the past? Do we have the tools and processes to do so in place? You know the quality of your products are ridiculously good and that they play a key role in the production of your clients. The value is definitely there. Your clients must be laughing at their internal meetings on how cheap you are!
Yes. Pricing! That’s where we need to focus.
You start piling through your inbox to find the slides on pricing effects from management training a few years ago.
A 1% price increase can account to a 20% EBIT increase with our current numbers.
As the meeting is coming to an end, you snap out of your profitability expedition and interrupt Kim as he’s still going on about the benefits of using new foreign suppliers. “My hypothesis is that we have a pricing problem. Kim, Lukas, Martin, could we sit down right after this meeting and review list and net prices, discounts and the rationale behind them?”
TO BE CONTINUED…
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Pertti Palosuo, Capacent's senior consultant has hands-on operational experience in supply chain optimization and performance management. At work, Pertti enjoys crunching numbers and is energized by working with clients.
Prior to Capacent, Pertti co-founded a consumer goods company, worked in sales for a global software organization and has obtained extensive experience in digital marketing.